For those of you slackers out there (I mean, really busy people who waited six months after the first tax filing deadline…), the October 15th extended tax filing deadline is a week and a half away. TurboTax is still offering the same promotion for extended tax filers that they offered back in March and April this year:

• Free Edition is still free, 1040EZ & simple returns, with free eFile,
• $49.95 Deluxe Edition for folks who don’t qualify for the Free Edition, it also includes free eFile,
• $74.95 Premier edition for those with investments and retnal properties, free eFile,
• Finally, $99.95 home & business with free eFile.

Free Edition Users: There is really no reason why you should be waiting this long to file your taxes. There is a pretty good chance that you are owed a refund, in which case you given the government an even longer than reasonable interest free loan (not that they’re complaining, they need it!), and your taxes aren’t nearly as complicated as you think they are. (oh, and you may have been delayed getting that tax stimulus check everyone else has already spent!)

Everyone else… you have a week and a half, get on it!

The Labor Department released inflation data yesterday and the Wall Street Journal had three tax experts estimate how all the inflation-pegged tax figures would change based on those numbers. Many tax numbers, like the brackets, exemptions, standard deductions, etc., are pegged to inflation so knowing the Labor Department figures can give you huge insight into how those numbers will move. The three experts are George Jones, senior federal tax analyst at CCH; William Massey, senior tax analyst for the tax & accounting business of Thomson Reuters; and Prof. James C. Young, professor of accountancy at Northern Illinois University. The Wall Street Journal does this every year and, for as long as I can remember, they’re often it pretty spot on. Based on their calculations, a bunch of inflation-pegged tax numbers are going up.

All these figures are merely estimates, the government can always go back and adjust inflation figures so these numbers may change.

2009 Federal Income Tax Brackets (Projected)

Here’s what they projected for the income tax brackets for 2009, compared to 2008 figures:

Some other changes:

• Standard deduction increases: The standard deduction for married filling jointly is expected to increase to $11,400 from $10,900, a $500 increase. Singles and those married filling separately will get a standard deduction of $5,700, a $250 increase from $5,450 in 2008.
• Personal exemption increases: The personal exemption amount will increase $150 to $3,650.
• $13,000 gift tax exclusion: Professor Young believes that that gift tax exclusion amount will increase from $12,000 to $13,000. Right now, if you give more than $12,000 a year to someone as a gift, you have to pay a gift tax on it (yes, the giver of the gift pays the tax). Professor Young believes that number will increase to $13,000.

More insight and explanation can be found at the Wall Street Journal and here were their predictions on last year’s IRS tax brackets.

A tax credit is not the same as a tax deduction.

Tax Deduction

A tax deduction, such as contributions to a Traditional IRA or 401(k), reduces your adjusted gross income. How much that deduction is worth to you depends on your marginal income tax rate (2008 Federal Tax Brackets).

If you are in the 25% tax bracket, a $1000 tax deduction means you will pay $250 less tax that year. If you are in the 10% bracket, a $1000 tax deduction means you’ll pay $100 less tax that year. If you have a simple tax situation, with little income outside of your regular job, this translates to a larger tax refund.

Common tax deductions are the two mentioned before, Traditional IRA and 401(k) contributions, as well as mortgage loan interest, student loan interest, and charitable donations.

Tax Credits

A tax credit is a dollar for dollar reduction in your income taxes. If you have a $1000 tax credit, you will pay $1000 less tax that year regardless of your tax bracket. A good example is the $1000 child tax credit. If your child applies and you don’t exceed the income limits, you get $1000 for each dependent child you claim on your tax return.

Common tax credits are the child tax credit, Hope Scholarship and Lifetime Learning Credits (education related), retirement savings credit, and the adoption tax credit.

With the recent passage of the 2008 tax stimulus package, many people have been asking what their adjusted gross income is and how that differs from their take home pay, their salary, and the other similarly named modified adjusted gross income. The differences are pretty simple once you understand the motivations behind it but it’s easy to confuse many of them together.

First off, you salary is the pre-tax amount your employer pays you to work for them. Next, your take home pay is your salary minus any deductions you may have for health insurance, retirement plan contributions such as a 401(k), taxes, and any other adjustments. Your take home pay is the dollar amount that gets written on the check (or is deposited into your bank account). Your salary is what you tell your parents when you get a job (it’s bigger).

Why is this important? The AGI and MAGI are often used to determine if you are eligible for certain benefits, deductions, etc. For example, the MAGI is used to determine contribution eligibility for IRAs such as the Roth IRA.

Adjusted Gross Income

According to the IRS, your AGI is all taxable income you earn including the following categories:

• wages,
• salaries,
• tips,
• taxable interest,
• ordinary dividends,
• taxable refunds, credits, or offsets of state and local income taxes,
• alimony received,
• business income or loss,
• capital gains or losses,
• other gains or losses,
• taxable IRA distributions,
• taxable pensions and annuities,
• rental real estate,
• royalties,
• farm income or losses,
• unemployment compensation,
• taxable social security benefits,
• and other income

minus

• specific deductions including educator expenses,
• the IRA deduction,
• student loan interest deduction,
• tuition and fees deduction,
• Archer MSA deduction,
• moving expenses,
• one-half of self-employment tax,
• self-employed health insurance deduction,
• self-employed SEP, SIMPLE, and qualified plans,
• penalty on early withdrawal of savings, and
• alimony paid by you.

Some argue that this is what appears on your 1099 or your W-2’s, but that’s not entirely accurate (self-employment tax isn’t even within scope for a 1099). The full list above is comprehensive and provided by the IRS so that’s the official story (source). Note one important item(s) missing from the “minus” list, the standard deduction or any other itemized deductions (like mortgage interest).

Modified AGI

How does the MAGI differ? You simply take your AGI and exclude the following (source):

• Any passive loss or passive income, or
• Any rental losses (whether or not allowed by IRC § 469(c)(7)), or
• IRA,
• taxable social security or
• One-half of self-employment tax (IRC § 469(i)(3)(E)) or
• Exclusion under 137 for adoption expenses or
• Student loan interest.
• Exclusion for income from US savings bonds (to pay higher education tuition and fees)
• Qualified tuition expenses (tax years 2002 and later)
• Tuition and fees deduction
• Any overall loss from a PTP (publicly traded partnership)

Relationships

So your MAGI will be higher than your AGI but smaller than your gross income. Your gross income will be your salary plus any other income, passive or active, and thus larger than MAGI or AGI (since they include subtractions for certain items).

Why is this important?

Knowing what makes up these numbers is important because those values will dictate what you are permitted to do, tax-wise. The best example is with a Roth IRA. If you file as a single and your MAGI is under $99,000 for 2007, you can contribute the maximum $5,000. If your MAGI is between $99,000 and $114,000 then your contribution is phased out (Roth IRA contribution phase outs). If your MAGI is over $114,000, then you can’t contribute to a Roth IRA.

So, if you know you’re within those phaseout ranges, you might want to contribute a little bit more into the 401(k) so you can take advantage of the Roth IRA. Since you know what makes up the MAGI calculation, you would be well informed and smart to do that (if you wanted to contribute to a Roth IRA).

There you have it, AGI and MAGI, all wrapped up in a pretty little (and somewhat complex) bow.

This article has been made somewhat obsolete for 2006 (2005 tax year). The rules are the same but the documents you reference have changed. See the note at the end of the article.

Welcome to the second article in a series I call Tax Relief 101 designed to help you save some cash from the tax man. You can see the whole collection under the category of Tax Relief 101.

When you are doing your federal taxes, you typically will deduct what you pay to the state in taxes from your income. That prevents double taxation because otherwise you would be taxed on money you paid to your state government. Well, the American Jobs Creation Bill of 2004 has a provision that now allows you to deduct what you’ve paid in state sales tax instead. It’s an ‘either or’ situation, you can deduct one or the other and you must pick. This is an option you can use on your 2004 and 2005 taxes.

First things first, this is for people who itemize deductions on a Schedule A. So if you claim the standard deduction, this option isn’t going to be possible for you. What this does mean is that if you always just claimed standard, perhaps a little investigation would reveal itemizing with state sales tax would produce a greater refund (lower tax liability).

Nine No-Brainer States:
Nine states don’t collect state income tax but to have some sort of state sales tax and so in those states it’s a no-brainer. If you’re a resident of Florida, Nevada, South Dakota, Tennessee, Texas, Washington or Wyoming and you itemize, deducting sales tax is the way to go. Alaska doesn’t have income taxes but some areas do charge sales tax and New Hampshire is the same situation except they only charge taxes on touristy-type activities like meals, hotel rooms, and vehicle rentals. Live elsewhere? Then you need to do the math and decide for yourself.

Calculating the Break:
You have two options: save your receipts or use IRS tables.
1. Save Your Receipts - Stick your receipts in a box, keep a running total, claim the deduction and when the IRS asks (which it probably won’t) then just show them the box.
2. Use IRS Tables - The tables are available here. The IRS document does a good job with its worksheets to help you find out how much you can deduct based on your adjusted gross income. [Pub 600 has been rolled into the Instructions for Schedule A & B]

Alternative: If you made a large purchase such as a car or boat, you can claim the average sales tax deduction from the tables using Method 2 and then add the tax on your large purchase. They might also add other large items like appliances or something similar.

WARNING: Check if you’ve been pushed into the Alternative Minimum Tax, because this might hurt you also. Remember to consider this as an input in your calculations.

I hope this has helped clear up any confusion you may have had regarding the whole “deduct sales tax” thing you might have heard around the water cooler.

2006 UPDATE: The sales tax rules for 2006 (applicable to 2005 tax returns) are roughly the same but Publication 600 no longer exists, it’s been rolled into the instructions of the Schedule A. I’ve written an update to these rules.